How to make tax officials accountable

The proposed simplification of the tax code offers a chance to instil accountability, following the model of the Public Service Guarantee Acts

A friend, Kalpesh, recounted an interaction with an Income Tax Officer (ITO) from a decade ago. Kalpesh, who ran a startup then, faced scepticism from the ITO, who suspected that high venture capital investments in his company, despite its losses, were part of a money-laundering scheme. The ITO added the share premium as “income from other sources”, resulting in a significant tax demand.

The startup was compelled to pay one-fifth of the substantial tax demand upfront. It appealed the assessment, but the Commissioner of Income Tax (Appeals) rejected it as expected. The company then turned to the Income Tax Appellate Tribunal, an independent judicial body, where it finally won.

But its ordeal did not end there. Securing a refund with a mere half per cent simple interest per month (in contrast to the one per cent simple interest charged for delays by taxpayers) required persistent follow-ups and took five years. Meanwhile, the company nearly collapsed due to the capital tied up with the tax department.

All this happened because tax officials still view most taxpayers as evaders. Moreover, the tax department lacks accountability, as evidenced by the delayed refund. The department has a perverse incentive to raise unreasonable demands since the one-fifth tax collected counts towards officials’ collection targets. Delays benefit the department, even if the taxpayer eventually wins. The transfer of the first appeal process to the National Faceless Appellate Centre in 2020 has only worsened delays, with few appeals resolved since then.

Taxpayers were less vocal when evasion was rampant. But the formalisation of the economy and the Tax Information Network have closed most evasion routes. Earlier it was the salaried, but increasingly self-employed taxpayers are also compliant. 

With nothing to hide, taxpayers are more vocal, as witnessed in the debate over withdrawing indexation benefits for long-term capital gains. The government is also paying attention, as is evident from the partial rollback of the provision.

The proposed tax code simplification offers a chance to instil accountability in the tax department. A model for this exists in the Public Service Guarantee Acts (PSGA) adopted by most Indian states. PSGAs set time limits for services like issuing certificates, ration cards, and driving licences. They establish an appeal process and hold officials accountable for delays, imposing fines on them and compensating the affected citizens.

The government has introduced a Taxpayers’ Charter in the Income-Tax Act, but it lacks teeth. To strengthen it, the charter should follow the PSGA model as follows:

One, set time limits for the tax department’s tasks such as rectification requests; deciding on requests for lower tax deduction at source; implementing appellate orders; and deciding appeals at the CIT (A) level. Two, hold specific officials accountable for meeting these deadlines. Three, impose fines on officials responsible for delays.

Four, eliminate the tax department’s incentive to delay cases. Allow interest on refunds at the same rate as the department charges, and make it tax-exempt. Alternatively, let taxpayers buy government securities for disputed demands, marking a lien in the tax department’s favour till the dispute is resolved. This will ensure that disputed demands are not counted as tax collection until the dispute is resolved. Meanwhile, the taxpayer will continue to earn interest during the dispute.

Truth be told, taxpayers hold little political influence, as they are just two crore in a population of 140 crore. However, they belong to the middle class and are valued opinion-makers. 

Their perception of the tax department’s fairness shapes their perception of the government. The government should remember this when implementing the Taxpayers’ Charter which it had the foresight to enact.

The writer heads Fee-Only Investment Advisors LLP, a Sebi-registered investment advisor; X (formerly Twitter): @harshroongta